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Alpha definition
Alpha is a performance measure that shows how much an investment returns above or below its benchmark. It captures the value added or lost by active decisions rather than by the market itself.
Alpha compares the return of a portfolio, fund, or strategy with the return of a reference index over the same period. A positive alpha means the investment beat its benchmark, while a negative alpha means it fell short. It is most often used to judge active managers against the market they trade in.
Alpha is read alongside beta, but the two measure different things. Alpha is the excess return earned over a benchmark, while beta is the investment's sensitivity to overall market movement. A fund can carry high beta and still post negative alpha when its gains come from market exposure rather than skill.
Alpha Example
A fund returns 12% over one year, while its benchmark index returns 9% over the same period.
Alpha is the gap between the two:
12% - 9% = +3%
The fund has an alpha of +3%, because it beat its benchmark by 3 percentage points.
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